When it comes to startups, shareholders agreements and funding rounds, vesting is a term that often comes up. But what about reverse vesting? It is an important approach to vesting for founders and employees or other team members to understand.
What is the difference between Vesting and Reverse Vesting?
Vesting is a process in which a company’s founders or team members are required, to in effect, earn their shares over a period of time, rather than receiving them up front. Reverse vesting is the opposite, the shares are issued up front but over a period of time remain subject to being forfeited (reverse vested). Vesting and reverse vesting are both used to protect the company and its shareholders in case a founder or key team member leave before they have met their personal targets or before the business has reached agreed milestones. The triggers for vesting or reverse vesting are usually linked to being a ‘good leaver’ or a ‘bad leaver’.
If you are in need of legal advice on vesting or reverse vesting please book a free introductory call with a member of our commercial law team .
How Does Vesting Work?
Both kinds of vesting typically involve a vesting schedule, which outlines the timeline and conditions for earning shares or the right to keep them. This schedule can vary depending on the company and the individual’s role within the company. It may also include milestones or performance goals that must be met in order for the shares to vest.
Reverse vesting works by granting equity upfront but with a repurchase right or means of converting the shares into worthless ‘deferred shares’. This means that if the individual leaves the company before their equity fully vests or another trigger event occurs, the company has the right to repurchase the unvested portion of their equity at a predetermined minimal price or, convert the unvested shares into deferred shares. This helps protect the company from losing a significant portion of its equity if a founder or key team member is no longer contributing to the business.
The terms of the vesting or reverse vesting can appear in a founder’s agreement, vesting agreement, shareholders agreement or in the articles of association of the company. The main terms will include the duration of the vesting period, the percentage of shares being forfeited, and the trigger events of forfeiture.
Why is Vesting Important?
Vesting is important for both founders, team members and investors because it helps align the interests of the founders and team with the success of the company before, or in addition to any option scheme of the company. It also potentially protects the company and the success of future funding rounds from having large shareholders who are inactive in the business.
How to Implement Vesting
If you are considering implementing vesting or reverse vesting in your company, it is important to consult with legal professionals and take tax advice to ensure that it is done correctly and in the most tax efficient way for the company and the recipients of equity. The best solution will depend on the stage of development of the company, the relationship of the recipients to the company and where they are subject to taxation.
Book a free legal consultation with JPP Law
Vesting may seem like a complex concept, but it is an important aspect to understand for both founders trying to protect the value of the business and for team members who have been offered shares or options that are subject to vesting terms. If you have any further questions about vesting, reverse vesting or option schemes please book a free introductory legal consultation with a commercial solicitor from JPP Law.
